Preparing your non-profit for an audit

What is the ASC 842 standard?

The Financial Accounting Standards Board (FASB) establishes generally accepted accounting principles (GAAP) for private entities and organisations. These principles are known as the Accounting Standards Codification (ASC) system. ASC 842 is the section dealing with leases. 

The financial scandals surrounding the collapse of Enron in 2001 led to the development of ASC 842. Prior to those events, organisations included only certain leases on their balance sheets – capital leases but not operating leases. Capital leases, also known as finance leases, typically involved depreciable assets, and ended with the business taking ownership of those assets. Operating leases involved the use of an asset like retail or office space. Enron used a loophole created by these two definitions. It used operating leases to hide a tremendous amount of liabilities. This cost shareholders billions of dollars and led to the loss of thousands of jobs.

ASC 842 defines a lease as an agreement conveying the right to use property, plant, or equipment, usually for a stated period of time. This definition helps close the loophole that Enron used by eliminating the distinction between capital and operating leases.

Organisations must include all leases that last longer than 12 months on their balance sheets. Some leases can be difficult to identify, such as leases that are included as part of a larger service contract.

The standard may also change how organisations prepare other financial statements. An operating lease is no longer just an ongoing expense, an obligation to pay monthly rent for office space. The right to use the property is an asset that goes on the balance sheet. The full obligation to pay rent over the term of the lease is a corresponding liability.

How will auditors test compliance with ASC 842?

ASC 842 will require major changes in how many NFPs handle their accounting. Auditors will look at an organisation’s leasing system to see how they have adopted to the standard. They will perform a risk assessment to identify potential areas of noncompliance. Questions they ask may include the following:

• Have you reviewed all contracts to identify all leases?
• Have you made accurate valuations of your leases, and does your balance sheet reflect those valuations?
• Do your financial statements accurately reflect the dates leases begin and end?
• Have you correctly identified finance and operating leases?

How can organisations prepare for audits?

Preparing for an audit that applies ASC 842 requires familiarity with the new standard. From there, your organisation can plan and prepare for the auditor’s likely questions as discussed above. Creating an inventory of all leases is an important early step in the process. This can be difficult if lease obligations are contained within larger contracts. Determining the present values of operating leases is also likely to be a challenge. CPA is a Senior Manager in Assurance Services at DMJPS. Isaac has comprehensive experience in auditing with a variety of industries, including hospitality, manufacturing, construction, real estate development, and non-profit. He provides a skillful approach in his work, which includes consulting, agreed upon procedure engagements, financial statement audits, reviews, compilations, and a wide range of targeted audit services.

Isaac Rowles CPA is a Senior Manager in Assurance Services at DMJPS. Isaac has comprehensive experience in auditing with a variety of industries, including hospitality, manufacturing, construction, real estate development, and non-profit. He provides a skillful approach in his work, which includes consulting, agreed upon procedure engagements, financial statement audits, reviews, compilations, and a wide range of targeted audit services.